A Story About KLCI

Since starting this blog back in Feb 2016, I feel that I have gained some exposure to multi facets of the capital markets. I am still trying to understand the capital markets that exist in my home market, Malaysia. Everyday appears to be rather new from my perspective. If, hypothetically, someone (i.e a stranger) asks me how would I describe the current state of Malaysia’s FBMKLCI, it will be an interesting question but surely, a difficult one to answer. Let me attempt at answering this question in this posting.

Declining ROE – reflecting issues with the Malaysian banking sector

The price-to-book (PBR) of FBMKLCI is currently below its median of historical PBR (current 1.70x vs historical median 1.79x).

As shown below, the PBR of FBMKLCI has fallen in tandem with FBMKLCI’s declining return on equity (ROE). The decline in ROE has started since year 2013 and has since stabilised at around low teen ROE of about 10.0%. As FBMKLCI is largely weighted by banking stocks, it is obvious that the declining ROE in the banking sector has pulled down the overall ROE of the FBMKLCI. Until and unless there is a strong recovery in the Malaysian banking sector, we may continue to see the PBR of KLCI to hover around and below 2 times.

Price-to-earnings ratio influenced indirectly by QE?

Currently, the FBMKLCI does not appear to be overvalued, as its PER is quite close to its historical median. However, there may be potential risk of further deterioration in future earnings that may push the FBMKLCI’s PER higher.

The thing about PER is that it depends on three (3) key components – dividend payout ratio, required rate of return (i.e return on market) and growth rate (in earnings / dividends).

The dividend payout for FBMKLCI has been on a declining trend. As shown below, the lower dividend payout has resulted in a lower PER being ascribed for the FBMKLCI:

In addition, growth in net dividend has peaked in 2015 and is currently on a declining trend:

In spite of declining dividend payout ratio and dividend growth rate, we did not see a significant decline in P/E for the FBMKLCI which may be attributable to a lower required rate of return expected for the FBMKLCI (may be due to ample liquidity in emerging markets as a result of global QE?):

Future dividends expected to be lower?

If compared to historical median of dividend yield, the FBMKLCI does not appear to be too overvalued (but its current dividend yield is lower than its historical median). Dividend yield may continue to be lower if there is lower dividend payout and lower growth rate in earnings / dividends.

Earnings have plateaued?

The following graph shows that the FBMKLCI earnings have not shown significant growth (in fact, may potentially be on a declining trend?).

Will we see another future credit crisis?

Low interest rate environment has pushed corporations towards raising more debt to fund their expansion plans. What is more worrying is whether these corporations are able to withstand a rising interest rate environment (due to reversal of QE) and lower future corporate earnings. The following graph shows that the net debt to EBITDA has increased significantly for FBMKLCI companies since 2009 (i.e the start of QE).

Tri Stars Pattern Emerging

A single Doji candlestick is an infrequent occurrence that is used by traders to suggest market indecision. Having a series of three consecutive doji candles is extremely rare, but when it is discovered, the severe market indecision generally leads to a sharp reversal of the given trend. The “three stars” pattern can also be used to signal the reversal of downward momentum when the pattern is formed at the end of a prolonged downtrend. Read more: Tri-Starhttp://www.investopedia.com/terms/t/tri-star.asp#ixzz4riBh06G9

The monthly chart of FBMKLCI shows that a tri-stars pattern has appeared:

Anyway, this is a short story about FBMKLCI. I have to admit that this is a rather muddled story which is meant to be inconclusive and fuzzy. Perhaps, there may be more clarity after the next General Election.

Special thanks to my good old friend, James for his contribution in extracting such valuable information.

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